Thursday, February 25, 2010

Still In The House Of The Unexpected

Only Wall Street economists can listen to The House of The Rising Sun and think it's a paean of optimism. On Main Street, the interpretation is perhaps more realistic. I may seem to be harping on this theme, but I saw some very remarkable research reports from Persons Who Should Know Better in the fall of last year.

Anyway ... if you will look back, you'll note that for the last few months I kept whining that all the large companies were still in cutting mode. Perhaps this has something to do with another "unexpected" rise in initial unemployment claims. This week's 496,000 SA number is less important than the continuing rise in the four-week average, which is now at 473,750. Still, for some perspective, we should remember that the comparable week in 2009 had initial claims of 656,000. There is a strong improvement. But it is very hard to look at a four-week average over 450,000 and think that we are going to be gaining much in the way of net jobs without a further step up in the economic cycle, especially once the Census jobs filter out and the full impact of the state and local fiscal situation hits this summer.

It is not that the larger company cuts are at all unprecedented. In the wake of the 75-82 cycle, large corporates cut for years. But at that time, much of the slack was taken up by small businesses which took over a lot of the cut functions and hired like crazy (and bought stuff like crazy). Thus it is the combination of an extremely depressed small business sector and large corporates still retrenching that make the 2010 picture so doubtful.

My guess is that the US will pull out at least a net +1.8% for the year, but that will not feel very wonderful if we end the year in another contraction. Sad to say, policy choices probably are determinant. I wish I felt more confident about policy-makers.

There is still some good left in this picture. Overall companies managed to make the Schumpeter turn in Q4 (according to tax receipts) which provides us some breathing room.

Today's durable goods report seems to show that we are nearing the end of the inventory clearing cycle. Specifically, look at metals. New orders for fabricated were up 2.2% Oct/Nov, down 2% Nov/Dec, and were flat Dec/Jan. Over the same period, new orders for primary metals went +2.6%, +10.1%, +1.9%. Shipments of primary metals peaked and dropped to a pace of 1.1%. The sequence on an inventory recession is dropping sales > increasing retail/wholesale inventory > slowing wholesale orders > slowing production > inventory builds down to crude materials. It reverses in order, and when the surge in crude materials passes, you have gone through the clearance cycle and ongoing production will reset to a pace equivalent to current sales flows. So we are mostly there.

New machinery orders confirmed by falling 9.6%. Motor vehicles new orders dropped 2.2%. There is still a hefty defense bulge in, but one wonders how long that can continue, and capital goods new orders ex defense and aircraft came in at -2.9%. The electronics/computers jump is still there and will provide another couple of decent months along with defense.

I also cannot stress enough that the durable goods report is currency based, not volume based. It should always be read in light of PPI trends for crude, finished and final goods. Since the 12 month change in prices for crude goods in January was +25.2%, YoY changes have to be seen in that light. The month over month changes are less affected.

Finally, oil inventories and prices do not make sense together. Inventories for every category are still above the upper bound of the average stock except for propane.

Gasoline demand is still turning in a YoY decline, which is not an indicator of economic improvement. In general gas consumption rises strongly in the early stages of recovery as jobs pick up. We have gone through a cycle where gasoline consumption did improve, and now that has retracted.

We are essentially dependent on overseas demand for improvement in corporate margins. That is why I am spending so much time on the Chinese situation.

Last, but not least, we have definitely reached the point at which gas consumption is strongly affected by prices. From the PPI report:

The Producer Price Index for the Net Output of Total Trade Industries fell 0.5 percent in January, its second consecutive decline. (Trade indexes measure changes in margins received by wholesalers and retailers.) About two-thirds of the January decrease is attributable to a 9.3-percent drop in margins received by gasoline stations. Margins received by general merchandise stores and home centers also fell in January, contributing significantly to the decline in the total trade industries index.

The reason gasoline stations drop margins is because they are fighting to keep business up. It's a dead giveaway that there's potential consumer economic trouble ahead. Once consumers are tight on gas, they are very unlikely to be spending freely on non-essentials.

M_O_M, defense spending might decrease absolutely if they cut a few big-ticket programs, but should remain broad over the next several years. There's a massive equipment-replacement cycle getting underway, and the primary RFP's are just getting processed now. Many types of vehicles are coming back from Iraq in no shape for anything but the crusher, and it's too expensive to just re-start the old production lines. Besides which, DoD (as usual) wants the newest, shiniest toys they can get their hands on. (For example, brand-new electric transmissions and auxiliary gear, to save on the fuel logistics. Less tank truck convoys = fewer dead tank truck drivers.)

This is going to provide gainful employment for a lot of engineers for a while (like, say, me). ;)

I tried to post last night I was hearing of a +500k Claims number but looking just now I see it didn't stick. Sorry about that. I don't know why I say this but it seems to me at this point in the cycle a +496 number is equally as bad as a +650 number a year ago. Call it Forest Gump.

Over the weekend I looked at several charts. The only bright spot was non defense capital goods. I guess after todays report we can scratch that one, too.

Finally, The consumer sentiment number. That speaks volumes to me. Maybe if the USA Hockey team wins the Gold Medal, that will be the catalyst to a better mood.

Finally (2) we discovered today that the market will be open Good Friday. Guess that's what happens when you have a Muslim in the White House named Hussain. Next time let's get a Jewish woman and we'll get all the holidays off!

CF - regarding the holidays and the president - but can we take the Jewish guilt? That is the question - after a decade or two of self-esteem we might not be up to it. Half the country would be in therapy. The other half would be on meds.

No argument, these are not good numbers. I had trough at last May because I saw an uptick in freight in June. But these are January and February numbers! CFNAI will come down again.

I would hate to think we'll be calling another peak in the first half of 2010, but if we don't deal with unemployment benefit expiration problem well, it certainly could happen.

I think the reason I am so nervous is that so much depends on public policy. This is never a good sign in economics.... The consumer sentiment numbers are really a function of fuel costs. People just figure out where they stand, and if they feel like they're sliding backward, they figure others are too. They're generally right.

I saw an old movie the other day (a comedy) and there was one joke in there that really tickled me. The hero is talking to an East German woman, and she says that she had family in the US - an uncle. But, she adds, he was one of the lucky ones. He got out in a balloon during the Carter presidency.

Several points - no full recovery without a small business recovery. - it could get years to get back to November 2007's level of economic activity.- Q4 GDP overstates the real condition of the economy due to the inventory cycle.- the excess capacity problem is real and is forcing a much harder and deeper cutback for businesses.- the job-finding rate is at an historic low.- smaller business (20 employees or less) are very exposed to the real estate market. I think I remember you and I discussing this a few years ago, and it's true. With the death of credit card financing, they're in deep.

Coming soon to a theater near you, the second dip. It's coming later than I expected last summer, but it's on the way. Small business out here is just trying to hang on; they're in no shape to add jobs.

There's no reason to expect Congress to actually address unemployment until April; they're still too busy deciding whether they can ram health care through reconciliation.

I think Congress will pass another job extension. Why not, it's not their money.

There is no Credit. I've banked at a private bank for over 20 years, which was taken over by B of A. recently. Last month it came time to renew my liquidity line. The banker called and said they would need full financials, tax returns and unlocking of my credit reporting at Equifax. Understand this is a liquidity facility- there are US Treasury securities in the account with a market value 6x's the amount of the POTENTIAL loan. You can imagine how that went.

A few years back BofA got caught absolutely defying FinCen guidelines to facilitate some shady dealers in their private banking division. In the wake of it they hired Fox from FinCen and I imagine they have some pretty stringent guidelines now.

That's what the protocol calls for, so that's what they asked for.

Equifax is ID standard, and the financial statements and tax returns are so they can prove they did their money laundering/financial crimes due diligence for BSA. See, for example, Section 103.178 and Section 103.121

The joy of it is that since you have financial interests in a number of different ventures, due diligence for you is supposed to include a check up of all those ventures. Ownership, etc. FinCen is also tightening up on all sorts of investment activity. The bank is supposed to compare your account assets with your stated income and net worth, for example. If there were a discrepancy and they hadn't SARed you, they would be in trouble.

MOM; Yes, I understand the Know your client, anti money laundering anti terrorist regulations. HOWEVER, if you hold yourself out as a personal banker wanting to service your high net worth individual, then don't treat them like someone that just walked in off the street. It's a secured loan for G-d sake.